Foreign investors pumped in over $23.2 billion this year and, unlike 2010, most of it went to the secondary markets despite all the negative headlines, says Huzaifa Husain, head of equities at PineBridge Investments India, a mutual fund owned by Japan's PineBridge Investments. An optimistic Husain says that purely from a valuation perspective, any downside from current levels seems unlikely. In an interview with ET, he says that if the money supply is tightened further, it may irreparably damage a lot of borrowers. Excerpts:

The markets have risen significantly in the last few months. Do you think some value is still left?

The present run-up should be seen in the context of virtually no returns for the past five years. From an irrational exuberance in 2007, when we saw India market capitalisation at nearly 160% of gross domestic product (GDP), we have now seen most of the excess being washed out. India now trades at close to 78% (market cap to GDP).

We believe that given the economic structure of India, this number should be close to 100%. We believe, purely from a valuation perspective, the risks of a downside from these levels are low. Recent developments on the fiscal front like subsidy rationalisation, market pricing of natural resources and disinvestment coupled with improving investment climate like FDI and National Investment Board will spur confidence among investors.

There is a lot of nervousness about political climate and policy deadlock which scare investors. What is your view?

This year, we saw the second highest inflows of $23.2 billion by foreign investors despite all the negative headlines. This probably can be explained by three factors like reasonable valuations, low yields globally and relative attractiveness of India. The revenue side of the budget is totally driven by taxing economic activity and urban citizens.

We find it inconceivable that politics will harm the economy in a sustained fashion. In the past ten years, infrastructure investments in India have increased from $40 billion a year to an estimated $200 billion a year. This places huge demand on the absorptive capacity of the country as well as on energy requirement. It is in this context that one should look at the present political situation.

What, according to you, is going wrong with Indian economy?

For India to grow at 7-8%, a huge amount of energy is required. Unfortunately, India has limited energy resources. The rest needs to be imported. Imported energy (coal, gas, etc.) is very expensive and makes fresh investment unviable. In the past 6-7 years, we have seen the gap between domestic and imported prices of energy going up significantly, which has made the situation worse. There are no easy solution to this problem.

The government is looking at various options such as increasing domestic production of coal and gas, price pooling of various sources of energy, pricing reforms, especially in the case of state electricity boards so that they can purchase energy from new plants. If global prices of energy come down, it will be an enormous tailwind to economic growth. It may also reduce pressure on the currency as the current account balance will improve. Â

How can the government solve energy deficit?

We need to invest a lot in producing more energy locally, especially since we have large coal and gas reserves. We need to start investing abroad and geographically diversify our sources of energy so that we are not dependent on any one country or energy source.

Is there further stress on banks' balance sheets? If so, how will interest rates pan out?

If you look at broad money (M3) growth, it is already down at 12.5%, which is lower than the nominal GDP growth. We, therefore, do not think that money supply can be tightened further without irreparably damaging a lot of borrowers. Hence, we think the interest rate trajectory will go down from now on even as its pace may be based on inflation numbers. For example, a 1% drop in interest rates can reduce the interest burden in the economy by Rs 50,000 crore or add 0.5% of GDP as stimulus.

Few Investments themes PineBridge is betting on?

Post 2008, we saw a huge fiscal stimulus towards consumption in the economy. In this light, we saw savings rate coming down and, correspondingly, investment growth rate dropping too. This has resulted in high inflation, high fiscal deficit, currency depreciation, etc. Now, we have reached a stage where it is imperative to improve investment rate in the economy. This looks difficult in the light of various legislations still pending, yet this is probably the only way left. Hence, from a valuation perspective, we are fairly confident of the industrial and cyclical plays of the economy. It may not have worked out for us this year, though we feel it may work out in the near term.